Why Stimulus Plans Fail
Saturday, Nov 5 2011

In theory, government stimulus ought to create jobs. In reality it often doesn’t. Why?

The first reason will surprise no one who pays attention to how markets and governments actually work, as opposed to how they “should”. The biggest problem is that government spending just increases the wages of those already well-connected to the government, instead of creating any new jobs.

The second problem is that when both the public and private sector are in debt, stimulus spending by government shouldn’t work even in theory.

Why governments rarely create jobs

The purpose of stimulus plans is to increase “aggregate demand”, or, in simpler terms, to increase consumer spending. Supposedly that increased spending will convince companies to hire. But consumer spending has already recovered to pre-recession levels, and that has not fixed the employment problem:

Companies still don’t want to hire, and the reasons may be very simple. Everyone is in crushing debt, which makes future prospects terribly uncertain. Hiring is a long-term decision, not a short-term one. Personal debt, as a direct result of the massive housing bubble, is higher than it has been at any point since the Great Depression. Total personal debt exploded from 4.6 trillion dollars in 1999 to 12.5 trillion dollars in 2007. It still stands at a whopping 11.5 trillion dollars.

In 1984, on average, household debt was 64% of personal disposable income. By 2007, it had reached an unsustainable 133% of personal income. It is still at 117% of income. Companies will be afraid to hire until individual Americans pay down more of their debts.

In theory, a government stimulus could still work under conditions of serious personal debt, but guess what? Even in theory, such stimulus plans can only work if the government itself is not in debt. If the government raises taxes to increase spending, then it is literally taking money from productive companies and giving it to unproductive companies. If the government borrows in order to spend more, when the employment problem is largely a result of enormous debt in the first place, then that will only discourage companies even further from hiring.

As usual, the best possible stimulus plan would be to just send everyone a check and hope for the best. If that sounds unappealing, well, these are the choices you end up with when you go into debt during the good times. When the bad times show up, you don’t have as many options.